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Trade War with China: Who Benefits?   (April 11, 2007)

Frequent contributor Albert T. has been alerting me in recent weeks to what he terms "the protectionist cycle" in which trade disputes ratchet up in rhetoric and action--with potentially dire consequences for the global and U.S. economy.

Those familiar with history will recall that protectionist tariffs are often cited as one of the proximate causes of the Great Depression. (For an excellent history of that era, correspondent U. Doran recommends The Great Crash 1929 by John Kenneth Galbraith.)

For a taste of just how widespread protectionist emotions have become, Albert sent these links:

U.S. Cites Partners for Unfair Barriers

China demands U.S. scrap anti-subsidy duties

China hits EU imports with tariffs

And in the midst of all this hullabaloo about China's trade surplus, we learn China's Trade Surplus Dives in March.

If we cool the rhetoric, then we might notice that China's China's record-high global trade surplus of $177.5 billion last year is dwarfed by the U.S.'s 2006 trade deficit of $805 billion and on par with Germany's massive trade surplus.

So is the problem that China is selling too much, or is the U.S. is buying too much?

I submit (documentation below) that the real benefactors of this huge trade imbalance are U.S. corporations, which have fattened their annual profits to $1.3 trillion, largely drawn from importing goods and services from Asia and then marking them up with huge profit margins.

But revealing that dirty little secret doesn't play well politically, so the usual hacks are out in force, demanding China rectify the imbalance created by gluttonous U.S. corporations and their shopaholic customers.

The Wall Street Journal's Morning Brief of April 10 summarized the situation as well as anyone:

U.S. relations with China have entered an era of aggressive trade policy, and this morning's trade numbers out of Beijing are only likely to bolster the hawkish case being made in Washington.

China's trade surplus in the first quarter widened to $46.4 billion, nearly double the $23.3 billion recorded a year earlier, the Chinese customs bureau said.

But despite Chinese efforts to reduce its trade surplus with eased import restrictions and export incentives, that lower number will do "nothing, zilch, nada to address political concerns in the U.S. about China's overall trade surplus," as economist Stephen Green of Standard Chartered Bank tells Bloomberg. "The numbers have now settled down, but still to a very high level."

For years -- and especially during the 2004 election year -- China has been the bete noire of both Democrats and Republicans in Washington who argued the government wasn't sufficiently protecting U.S. workers from unfair trade practices abroad. By filing formal complaints with the World Trade Organization yesterday, the Bush administration was, in effect, "finally doing to China what it has alternately implied, suggested, hinted and sometimes vaguely threatened it would do," Variety notes.

Ten days after it reversed years of policy with the imposition of potentially steep tariffs on some Chinese paper imports, the administration accused China of failing to halt the rampant piracy of U.S. movies, music, books and other intellectual property. In fact, trade specialists and industry officials tell the New York Times the move was in part a signal to Democrats who planned to legislate even tougher sanctions if the administration hadn't acted.

But "the new policy risks angering or embarrassing those in Beijing who may be trying to reform economic policies as Washington wants," the Times says. "In addition, many trade experts worry that China might retaliate against American imports or cut back on cooperation sought by Washington on other issues, like diplomatic problems involving Iran, North Korea and Sudan."

The head of China's largest beverage maker, Zong Qinghou of Wahaha, accused the French food giant Danon of failing to understand China and Chinese culture. "I told them the Chinese have stood up and the era of invasions by eight-country armies is long-gone," he said, in remarks the Financial Times notes were "unusually aggressive and nationalistic."
The protectionist hysteria gaining mindshare in Congress may be good politics to some, but it overlooks one simple fact about U.S.-China trade: the U.S. is making out like a bandit.

What supports this shocking statement? Everything. If anyone has cause to get sore, it's the Chinese, and here's why.

  • While most Chinese manufacturers have to settle for razor-thin profits due to extreme competition--according to BusinessWeek, 5% or less ("How Rising Wages Are Changing The Game In China"), American corporate profits are rising to unprecedented heights (see chart above). U.S. corporate profits have risen 10% or more, quarter after quarter, for 14 straight quarters--the longest run of such rich returns ever.

    So who's making all the profits in this trade? The U.S. companies. This was carefully documented in an August 2005 article in Foreign Affairs entitled A Trade War with China?. The author demolishes all the hearsay arguments about how trade with China is detrimental to the U.S. economy, revealing that much of China's manufacturing is owned and managed by foreign corporations. In effect, the companies aren't Chinese at all; only the workers are Chinese.

  • It's Chinese manufacturing which is getting squeezed, not U.S. companies. Unfortunately for China, this low profitability isn't going to change for the better. Why? Because global manufacturers can simply pack up and move to lower-cost rivals such as Vietnam. As reported in BusinessWeek Imports From China Aren't Pricier -- Yet (March 27, 2006):
    These days manufacturers in China seem unable to pass on the higher costs. Wage inflation is "eating into margins. There is very little pricing power in China -- or globally, anywhere -- anymore," says Michael Barbalas, general manager at the Suzhou factory of Andrew Corp., a Westchester,Illinois maker of wireless networking gear. "You can't negotiate with Wal-Mart , and if you're selling to the large electronics firms, you don't have a lot of pricing power, either."
  • In essence, China is competing not with the U.S., but with other low-cost manufacturing nations. The choice for many companies isn't between manufacturing in the U.S. or abroad; the choice is between suppliers of low-cost labor and infrastructure: China. Vietnam, Mexico, Romania--anywhere but the U.S.

    For people bemoaning the loss of manufacturing jobs in the U.S., here's a suggestion: get real. Companies go where they have to in order to survive and prosper in a world where foreign corporations will gladly take sales away from them. If they don't compete on quality and price, they wither. For a better understanding of the realities of the global marketplace, read this Foreign Affairs article, Offshoring: The Next Industrial Revolution?

    Many U.S. companies still have huge American manufacturing workforces--Catepillar and Boeing come to mind, both global leaders which generate big profits--but they also manufacture components in other nations as well, for a number of compelling reasons which may have little or nothing to do with low-cost labor. Boeing, for instance, essentially guarantees sales in Japan by subcontracting out the wing assemblies to high-tech Japanese manufacturers. No parts made in Japan, no sales in Japan, and so fewer planes made in Seattle. Pink slips fly, both in Japan and America--not good for anyone.

    If you compare the rates of "hard core" long-term unemployment in the industrialized nations (see chart), then you'll see that the U.S. workforce has a far smaller problem than the European nations, which are staggering beneath a long-term unemployment rate of 40% - 50%.

  • While cheap goods from China have boosted U.S. corporate profits enormously, they've also lowered inflation and prices in the U.S. As Wal-Mart et. al. like to remind us at every opportunity, all those cheap goods from China have benefited the working families who shop at Wal-Mart. While it's easy to sniff at this benefit if you're an upper-income academic, if you're a working stiff trying to get by on $400 a week, it's a very real benefit.

  • Meanwhile, what have the Chinese gained? How about a real estate bubble of epic proportions? All those U.S. dollars flowing into to China have caused a monster asset bubble, just as massive liquidity in the U.S. has fueled our own housing bubble.

  • There's another downside for the Chinese in accepting all this low-cost manufacturing: massive environmental degradation. Global corporations not only get the cheap labor in China and other less-developed countries, they also get a pass on all those pesky and expensive environmental regulations. Who pays for this rampant environmental dumping? The Chinese people, in lower life expectancy, and eventually, in taxes they must pay to clean up the monumental mess.

  • If you look past all the hysteria, you'll find that China's imports and exports are similar to Germany's; it's the U.S. balance of trade which is completely out of whack. According to the excellent resource website GeoHive, China's trade is far less imbalanced than Germany's, which was $914 billion in exports and $717 in imports for a $200 billion surplus in 2004. Yet who's complaining about Germany's huge trade surplus? No one.

    The U.S., on the other hand, exported $819 billion and imported an astonishing $1,526 billion in 2004--and the imbalance grew to $805 billion in 2005 before dropping slightly (due to the lower cost of oil) to "only" $765 billion in 2006. For more statistics, visit the U.S. government site of the Bureau of Economic Analysis.

  • As if all that isn't enough, the Chinese have also been obligated to support our consumer economy (which rests on massive liquidity, debt and asset bubbles) by buying $1 trillion of our low-return Treasury bonds. For that favor, they now stand to lose a huge chunk of their cash should the dollar decline--an outcome most experts consider inevitable.

  • So exactly what are the Chinese gaining from this supposedly favorable trade? How about massive environmental damage and the resulting health costs, a potentially devastating asset bubble, a trillion dollars in risky dollar-denominated bonds, and a bunch of foreign-owned factories which will move to the lower-cost competition once wages rise in China. Meanwhile, what has the U.S. gained? Enormous, unprecedented corporate profits, offshored environmental waste, cheap goods, and the off-loading of huge debt.

    So who's in denial about the benefits to American companies of the "trade imbalance"? Who's in denial about American ownership (or half-ownership) of factories in China? Who's in denial that eliminating the trade with China won't bring a single job back to the U.S. but will export those jobs to Thailand, Vietnam, Romania, Mexico, India, etc.?

    Before we launch a politically expedient trade war, perhaps we should consider who's benefited from the trade to date.

    Here is a piece I wrote on the subject way back in 2005: China Trade Surplus: Gusher Profits for U.S. Corporations (8/13/05)

    Note: some parts of today's entry were drawn from an August 2006 entry on the same subject.)

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